Posted by Amal on Tuesday, March 16, 2010 at 1:38pm.
Suppose you’re thinking about buying a used car, but you’ve become worried about the selection problems. In this market, the seller of each car knows the true value, but the buyer can’t determine the value until after purchase. Assume that there are 6 sellers with cars of value {$0, 1000, 2000, 3000, 4000, 5000}. (12 points)
a.What is the average value of a used car on the market?
Average value of used car = $(0 + 1000 + 2000 + 3000 + 4000 + 5000)/6 = $2500
b.If the buyer knows the average value of cars on the market, but not the actual value of any car, what is the most the buyer will pay?
$2500
c.Given what the buyer is willing to pay, which sellers will be willing to sell?
Sellers 1, 2 and 3, who have used cars that are valued at $0, $1000 and $2000.
d.Now consider the iterative (repeat the above process) behavior of buyers and sellers. If the sellers with higher valued cars than what buyers are willing to pay have left the market, now: Hint: The answers to 3b and 3d cannot be the same.
i. What is the most a buyer will be willing to pay?
ii. Which sellers will be willing to sell?
iii. What has happened to this market?
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